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Friends and Family Fraud: LLC Does It

Enforcing the Law Against a Market Designer: SEC LLC Stock Insider Trading Fraud on the Dark Web

On Wednesday, May 5, 2021, the U.S. Securities and Exchange Commission (“SEC”) instituted an administrative proceeding under Rule 102(e) of the SEC Rules of Practice against Seth P. Levine, Esq., a 52-year-old New Jersey attorney (also admitted in New York) residing in Teaneck, Bergen County, New Jersey, regarding charges of fraud through his LLC. Levine consented to the SEC action and agreed to be suspended from appearing as an attorney before the SEC. This administrative action followed on the heels of two separate judicial proceedings in the United States District Court for the District of New Jersey: on March 18, 2021, Levine consented to the entry of a judgment of liability for committing securities fraud in a civil case brought by the SEC; and on the same date, he pled guilty to two-count information for committing bank fraud and securities fraud in a case prosecuted by the Acting U.S. Attorney for the District of New Jersey.

LLC Does It

The SEC civil action resulted in a permanent injunction from violating the securities laws and the imposition of a disgorgement order and payment of a civil penalty, the amounts to be determined after discovery and motion by the SEC. The criminal proceeding resulted in an order that Levine forfeits all real and personal property obtained with the proceeds of his fraud. In addition, the bank fraud conviction carries a maximum penalty of 30 years in prison and a $1 million fine; securities fraud has a maximum penalty of 20 years in prison and a $5 million fine. Sentencing for the criminal convictions is scheduled for July 26, 2021. One suspects that Levine will also lose his license to practice law in New York and New Jersey.

According to the pleadings and a Department of Justice press release dated March 18, 2021, Levine was a real estate attorney practicing in New Jersey who in 2005 founded Norse Holdings, LLC, a real estate investment and management company organized as a New York limited liability company (LLC) and headquartered in Hackensack, New Jersey.

The SEC Complaint notes that Norse Holdings, LLC, was not registered with the SEC. Levine controlled at least 70 multifamily apartment buildings comprising approximately 2500 apartments, primarily in New Jersey, but some in neighboring states such as one in Wilmington, Delaware, mentioned in the pleadings. Levine supposedly set up a separate LLC for each property and sold membership interests in each of them. Each of the LLCs was to have separate bank accounts and operations. Levine also falsely claimed that he was investing significant amounts of his personal funds in each of these LLCs.

Friends and Family Fraud

The Operating Agreements for the LLCs contained the following provisions, which, in addition to maintaining separate accounts, seemed on their face to protect investors:

  • Members, including Levine, could not sell their membership interests without majority consent
  • Levine was further restricted from selling unless he offered the other members the same chance to sell
  • New membership interests could not be issued without unanimous consent
  • Levine was the Manager of each LLC responsible for maintenance and utilities
  • Levine could not borrow funds or refinance without majority consent
  • Distributions of net cash flow were to occur annually, and on a best efforts basis, quarterly

Despite these provisions Levine, according to the SEC Complaint, “fraudulently raised money through the sale of membership interests in [those] limited liability companies, including defrauding family, friends, and other investors, many of whom belonged to the Orthodox Jewish community.” In fact, according to the pleadings, Levine “provided investors with fraudulent documentation to show false profits, occupancy rates, and income and expense figures related to the apartment complexes.”

LLC Banking Fraud

Levine also provided the investors with falsified performance reports and fraudulent K-1’s. He “sold overlapping ownership interests in the [limited liability companies] to the investors, using false operating agreements and, at times, forged signatures.” He “frequently commingled investor funds among the [limited liability companies] in order to prop up struggling operations at certain properties and to make Ponzi-like payments by using new investments to pay earlier investors.” Levine frequently ignored needed maintenance and repairs, so that the properties lost value, and in some cases, he did not pay the utility bills. Nonetheless, the SEC Complaint notes that “between February 2015 and August 2019 Levine sold ownership interests in nearly 50 [limited liability companies], raising over $20 million …from more than 60 investors.” These fraudulent sales of securities cost investors in the aggregate over $5 million.

In addition, Levine committed bank fraud, borrowing more than $150 million using fraudulent rent rolls, and falsified 12-month income and expense records from the LLC. The loans from banks “secured” by mortgages and assignments of rent were then sold to the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). As the Department of Justice’s March 18 Press Release states, “Because the …[financings] were obtained with fraudulent data regarding the properties’ income and expenses, the multifamily properties were overvalued [and] rents and other income from the properties did not cover the mortgage payments and other expenses associated with the properties.

LLC Securities Fraud

To cover the shortfalls, Levine obtained additional cash-out refinances, thereby increasing … [the] total debt incurred. When the dust settled, “the outstanding balance of the fraudulently obtained mortgages … was more than $105 million, including 40 mortgages held by Freddie Mac with … [a] loan balance of approximately $103 million.” The losses to the victimized banks were “at least $65 million.”

In all probability, Norse Holdings, LLC, was functioning as an unregistered broker/dealer in conducting the sales of the membership interests, which the SEC asserted, without contradiction, are securities. Levine was similarly an unregistered broker/dealer and/or the unregistered principle of an unregistered broker/dealer. But these violations pale in comparison to the securities fraud conviction of the LLC. One must also note that this case is a cautionary tale about the great flexibility of what in Delaware are termed “alternative entities” (i.e., not corporations) with all of the flexibility in architecture afforded by a contract-based regime.

Fraud Prevention

The Levine cases demonstrate how that flexibility can be used as a device to siphon money from the unsuspecting. In this age of Madoff and others, every investment should be viewed with a skeptical eye. Clearly, perhaps in part because of Levine’s exploitation of connections in a religious community (frequently termed “affinity fraud”), the level of diligence used to evaluate these investments was less than was “DUE.” In any venture, investment of the “opportunity” must be examined as though it were actually a potential fraud. The experienced securities attorneys from Norris McLaughlin, P.A., may be able to help.

On another front, why didn’t the lending banks do a better job of complying with prudential bank regulator “Know Your Customer” obligations? Where were the appraisals, audits, and inspections that should have revealed the falsified rent rolls, maintenance failures, and unpaid utility bills, especially under the enhanced scrutiny of lending in the aftermath of the Great Recession and the Dodd-Frank legislation? Experienced banking attorneys, such as those at Norris McLaughlin, P.A., have frequently assisted lending institutions to establish their protocols for evaluating potential financings.

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